Professional Documents
Culture Documents
1. The following are balance of payments (BOP) statistics for the United States.
2002 ($000,000)
Goods: exports
Goods: imports
Services: credit
Services: debit
Income: credit
Income: debit
Current transfers: credit
Current transfers: debit
Capital Account: credit
Capital Account: debit
Direct investment abroad
Direct investment in the
USA
Portfolio investment
assets
Portfolio investment
liabilities
Other investment assets
Other investment
liabilities
Net Errors and
Omissions
Reserves and Related
Items
685
1165
289
227
256
260
12
70
1
2
138
40
-16
421
53
246
-47
-4
2. You recall that a month ago the U.S. dollar/yen spot exchange rate was
bid $0.008600/ and ask $0.008610/. Today you went to the bank and saw
the following rates being advertised:
Spot
Bid ($/)
0.008805
Ask ($/)
0.008815
30-day forward
60-day forward
0.009025
0.009225
0.009040
0.009275
Bid ($/)
1.4905
1.4975
Ask ($/)
1.4925
1.4995
60-day forward
1.5125
1.5155
You recall that a month ago the spot exchange rate was bid $1.4765/ and
ask $1.4775/.
ix.
What is the percentage appreciation/depreciation of the dollar
(1.0047% dep) and the pound (1.0152% appr) over the last month?
(Use only the Ask quotes for this computation.)
x.
What is the annualized 30-day forward premium/discount on the
dollar (5.6020% disc)? (Use only the Ask quotes for this
computation.)
xi.
What is the percentage bid-ask spread on the 60-day forward?
(0.198%)
xii. Interpret the forward premium or discount computed in ii.
I have a general Question regarding depreciation and appreciation of a
currency. For example in problem 5 Chapter 18 in the book the spot rate is
ringgit3.8000/$ and the ringgit is expected to appreciate by 2%. How do I
calculate the expected exchange rate?
If you MULTIPLY by (1 + expected change) then you are computing either the
appreciation or depreciation of the FOREIGN currency the one under the slash
($).
If you DIVIDE by (1 + expected change) then you are computing either the
appreciation or depreciation of the HOME currency the one above the slash
(Ringgit).
Recall that to find the appreciation/depreciation of the HOME currency
(above slash), you can leave the exchange rate quote as is above and use the
following formula: (beginning ending)/ending.
So this gives: (3.8 ending)/ending = 0.02 (3.8 ending) = ending 0.02 3.8
= ending + ending 0.02 3.8 = ending(1 + 0.02) ending = 3.8/(1 + 0.02)
Note that if the Ringgit was expected to depreciate you would still follow the same
procedure, but set the 0.02 as -0.02, so you would get ending = 3.8/(1 - 0.02).
Note that if the $ was expected to depreciate you would still follow the same
procedure, but set the 0.05 as -0.05, so you would get ending = 3.8(1 - 0.05).
5. On your visit to the bank you also noticed the following rates:
0.6512/$
NOK8.2033/
NOK5.4543/$
i. Is there an arbitrage opportunity? If so, demonstrate clearly how you
can take advantage of it.
By writing the quotes so that each numerator currency cancels out with
itself in the denominator of the three quotes, we should get a product of 1.
There is arbitrage if:
0.6512/$ NOK8.2033/ $0.1833/NOK 1.
NB: [$(1/5.4543)/ NOK = $0.1833/NOK]
The product is equal to 0.9794, which is < 1, indicting there is an arbitrage
opportunity.
Because the product of the exchange rates is less than 1, all three exchange
rates are expected to increase so that their product becomes 1. If the
rates are expected to increase it means the numerator currency in each
quote is expected to depreciate and the denominator currency is expected
to appreciate. You should but the currency expected to appreciate by
selling the one expected to depreciate.
Assuming you are a U.S. resident:
Sell $1m to buy $1mNOK5.4543/$ = NOK5,454,300
Sell NOK to buy NOK5,454,300/ NOK8.2033/ = 664,890.96
Sell to buy 664,890.96/0.6512/$ = $1,021,024.20
You have made a profit of $21,024.20 on $1m or 2.10242% return. This
could have been inferred from the fact that if you had 0.9794 increased to 1,
the return is (1-0.9794)/0.9794 = 2.10%.
NB: The above could also have been done using:
$1.5356/ 0.1219/NOK NOK5.4543/$ = 1.0210 > 1, indicating a 2.10%
profit.
ii. The bank also quoted the dollar against the euro as $0.9050/. What is
the cross rate between the euro and the Norwegian kroner (/NOK)?
0.6575/$
ii. The bank also quoted the yen against the dollar as 125/$. What is the
cross rate between the yen and the Canadian dollar (/C$)?
7. You are quoted the following exchange rates between the U.S. and
Canadian dollars and interest rates in each country:
Current spot:
C$1.4900/$
1-year forward rate:
C$1.5100/$
Canadian interest rate:
5.0%
U.S. interest rate:
7.5%
(Assume that you can borrow or lend at the quoted interest rates.)
i. Is there an opportunity for arbitrage? If so, demonstrate clearly how
you can take advantage of it.
8. You are quoted the following exchange rates between the yen and the
U.S. dollar and interest rates in the U.S. and Japan:
Current spot:
127/$
1-year forward rate:
125/$
Japanese 1-year interest rate:
1.5%
U.S. 1-year interest rate:
5.5%
(Assume that you can borrow or lend at the quoted interest rates.)
i. Is there a covered interest arbitrage opportunity? If so, demonstrate
clearly how you can take advantage of it.
F1h / f (1 i h )
the above. One side should rise and the other should fall for the two to
become equal. That is, ih is likely to rise and if fall (or the forward rate fall
and spot rate rise).
We could profit if we:
1. Borrow yen and convert to dollars at spot rate
2A. Invest dollars at US interest rate for a year
2B. Forward sell the dollars expected from the US investment (all or part
depending on ones residency) at forward rate to get yen in one year
3. At end of year, deliver dollars to get yen, and repay yen loan to make a
profit
Convert $5m to kr
$5,000,000 x kr6.1720/$
= kr30,860,000
2.
Invest/deposit/lend kr at Danish interest rate for 90 days kr30,860,000 x
1.0125 = kr31,245, 750
3.
Simultaneously, sell kr forward to get $ in 90 days forward rate locked in
= kr6.1980/$
4.
10. Suppose that the current spot rate between the Mexican peso and the
U.S. dollar is MP10/$. Over the next year the rate of inflation in Mexico is
expected to be 12% and in the U.S. it is expected to be 3%.
i.
ii.
11. Suppose that the spot rate between the Jamaican dollar and the U.S.
dollar a year ago was J$45/$. Today the spot rate is J$40/$. During the year
the rate of inflation in Jamaica was 8% and in the U.S. it was 3%.
iii.
Given the difference in inflation rates, one year ago what exchange
rate (J$/$) would you have predicted for today?
Using the RPPP formula that links expected spot rate to inflation
differential, the expected real or PPP exchange rate at time t (in this case t
= 1) is
S
h/ f
t
h/ f
0
(1 i h ) t
1.08
J $45 / $
J $47.1845 / $ .
f t
1.03
(1 i )
0.0250 (1.08)
1
0.0222 (1.03)
13. You are asked to use the futures market to hedge an expected cash
obligation of (Australian dollars) A$150m due on December 17, 2001. The
current spot rate is $0.6500/A$. The size of the futures contract is
A$100,000 and the price of the futures contract that expires on December
17 is $0.6650/A$.
i.
Should you buy or sell the futures contracts and how many?
Should you buy or sell the Call or the Put in order to hedge?
ii.
Profit = A$150,000,000*($0.6735/A$
$975,000
[$0.6635/A$+$0.0035/A$]) =
15a. On October 15, you were asked to hedge an expected cash inflow of
$15m Canadian dollars to be received on December 17, the delivery date of
the December futures contract for Canadian dollars on the CME. The
current spot rate is $0.5756/C$ and the current Canadian dollar futures
price for December delivery is $0.5872/C$. The Canadian dollar futures
contract is for C$100,000.
iii.
Should you have bought or sold futures contracts, and how many,
in order to hedge?
iv.
What is your profit or loss on the futures contracts if on December
17 the spot rate is $0.6082?
15b. Suppose the initial and maintenance margins on the Canadian
dollar futures are $1,500 and $1,100 per contract, respectively. Assume
that after hedging the futures closed at $0.5778 on the first day and then at
$0.5915 on the following day. Show the changes to the margin account,
indicating if there was a margin call and how much was it. (This can be
done using only one contract.)
16. A. 1. i. You will borrow $25m in 3 months time for a term of 6 months. The
loan rate will be LIBOR6+250 basis points. LIBOR6 is currently 2.5%. You enter
into a forward rate agreement (FRA) at a forward rate of 2.5%. If in three months
LIBOR6 is 1.5%, clearly show your net position from combining the FRA with the
loan.
ii. From part i, suppose the 6-month Eurodollar interest rate futures at the time
was 97.30. Should you buy or sell futures contracts to hedge? Clearly show your
net position from combining the Eurodollar futures and the loan.
B.i. You will borrow $10m in 3 months time for a term of 3 months. The
loan rate will be LIBOR3+150 basis points. LIBOR3 is currently 3.5%. You
enter into a forward rate agreement (FRA) at a forward rate of 3.5%. If in
three months LIBOR3 is 5.25%, explain fully how a FRA helped you.
Your concern is that LIBOR will increase at the time you lock in the rate in
three months time, resulting in a higher interest payment on the loan. So
you want to buy the FRA so that if LIBOR increases you get rewarded with a
cash inflow to use to partly offset the higher interest payment on the loan.
If LIBOR3 settles at 5.25% in three months your loan rate with the bank is
5.25 + 1.50 = 6.75%. For a 3-month loan the interest payment is:
$10,000,000*0.0675*(90/360) = $168,750.
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By choosing a forward rate of 3.5% you are trying to obtain an effective loan
rate of 3.5 + 1.5 = 5.0%. If LIBOR settles at more than 3.5% when you are
ready to take the loan you will obtain a payoff from the FRA equal to:
FRA payoff = $10,000,000*[0.0525 0.035]*(90/360)
1+ (0.0525*(90/360))
= $43,183.
This is the PV today of the payoff from the FRA which occurs in three
months time at the date that you get the loan. Its value in the three
months time when you get the loan is $43,750.
Hence, considering the inflows from the FRA in three months, your net
interest payment is $125,000. This is what you would have paid if you got
the loan at 3.5% + 1.5%, the rates you lock in with the FRA.
ii. From part i, suppose the 3-month Eurodollar interest rate futures at
the time were 96.30. Should you buy or sell futures contracts to hedge?
Explain how the Eurodollar futures helped you.
Since you fear an increase in interest rates are going to increase your loan
cost, you need to hedge in the interest rate futures market in such a way
that if interest rates do increase in the future you get an inflow of cash
(profit) so that you can use it to partly offset the higher rate you would pay
on the loan.
So, you need to SELL futures contracts today. If interest rates increase later
the contracts lose value and so you can buy them back cheaper and make a
profit.
The interest rate implied by the futures contract is 100 96.3 = 3.70%.
The price of $10,000,000 of contracts today is: $10,000,000 *[1 - .
037*(90/360)] = $9,907,500.
At expiration the spot interest rate is the same as the futures interest rate.
If this rises to 5.25% then the value of the futures contract will fall (price
and interest rates move inversely for fixed income securities).
The new price is: $10,000,000 *[1 - .0525*(90/360)] = $9,868,750. You will
buy the contract at this price and by doing so discharge the legal obligation
imposed on you when you sold the futures. Your profit in the futures market
(not considering brokers commission, initial margin, and margin call) is
$9,907,500 - $9,868,750 = $38, 750. This will be used to partially offset the
higher loan cost.
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You should then get a net borrowing rate for Y as LIBOR +0.25 0.45 =
LIBOR 0.20%.
<<< This is the best rate it could borrow on its own in the market it prefers
(floating) minus the benefit from the swap.
Follow the example done in class to draw the flows with the swap bank in
the middle.
21. The Land's Beginning Company Inc. (LBC), located in Seattle, imports extreme
condition outdoor wear and equipment from The Hudson Bay Company (HBC)
located in Canada. With the steady decline of the U.S dollar against the Canadian
dollar LBC is finding a continued relationship with HBC to be an increasingly
difficult proposition. In response to LBC's request, HBC has proposed the following
currency risk-sharing arrangement. First, set the current spot rate of
C$1.2000/$ as the base rate. As long as spot rate stays within 5% (up or down)
LBC will pay at the base rate. Any rate outside of the 5% range, HBC will share
equally with LBC the difference between the spot rate and the base rate.
i. Given the current spot rate is C$1.2000/$, what are the upper and lower limits
for trading to take place at C$1.2000?
ii. If LBC has a payable of C$100,000 due today and the current spot rate is
C$1.1250/$, how much does LBC owe in U.S. dollars?
22. Du Pont has entered into a currency risk sharing arrangement with
British Gas. Under the contract, Du Pont agrees to pay British Gas a base
price of $10 million for gas purchases, but the parties would share the
currency risk equally beyond a neutral zone, specified as a band of
exchange rates: $1.67/-1.73/. Within the neutral zone, Du Pont must pay
BG the pound equivalent of $10 million at the base rate of $1.70/.
Suppose the spot rate at the time of payment is $1.63/. How much will Du
Pont owe British Gas?
Amount owed in f.c. at base rate = ($10,000,000/($1.70/ )) = 5,882,352.94. This
amount to the party receiving the funds will not change if the rate is within the
zone when payment is due.
This could cost the payer between 5,882,352.94*$1.67/ = $9,823,529.41 and
5,882,352.94*$1.73/ = $10,176,470.59 within the zone.
Now that the spot rate is $1.63/, Du Pont alone would benefit from the
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the parties would share the currency risk equally beyond a neutral zone,
specified as a band of exchange rates: $1.67/-1.73/.
This implies using the upper or lower bound as appropriate to make the
adjustment to the base rate, just as you point out above that it does.
Note also for this contract that if the rate falls within the neutral zone, Du
Pont must pay BG using a fixed exchange rate (the base rate) of $1.70/.
Now look at chapter 12 # 5 and see what it says:
However, if the spot rate at the time of the shipment falls outside of this +/- 5%
range, Morris Garage will share equally the difference between the actual spot
rate and the base rate. This is what we did in class and is expressed in your first
formula above.
Note also that this contract says that if the spot rate falls in the +/ 5% range the
actual spot rate is used.
These are two different contracts. This is what I was saying in class that it
depends on the contract.
23. In December your firm had an obligation of CHF8 million due in June, around
the expiration date of the June futures and options contracts. You were asked to
hedge exchange rate risk and you gathered the following information.
DECEMBER
a. Spot exchange rate was (S0): $0.9000/CHF.
b. 180-day forward (F180) quotes for the Swiss francs: $0.9268 - 72/CHF.
c. Eurocurrency rates from a local bank
Term
6-month borrowing rate
6-month deposit rate
U.S. dollar
4.00% p.a.
3.90% p.a.
Swiss francs
1.05% p.a.
0.95% p.a.
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